Central Banks Rush to Protect Themselves from Incoming Disaster

Central Banks Rush to Protect Themselves from Incoming Disaster
Image courtesy of European Central Bank

From Birch Gold Group

The times, they are a-changin’, as Bob Dylan tells us.

On the global economic stage, the U.S. isn’t the dominant economic superpower that it once was. This conclusion comes from the declining popularity of dollars among global central banks.

Around the world, national central banks stockpile “reserves” in order to back up the value of their own national currency. Here’s how Investopedia explains monetary reserves:

  • The currency, precious metals, and other assets held by a central bank or other monetary authority
  • Monetary reserves back up the value of national currencies by providing something of value that the currency can be exchanged or redeemed for by note holders and depositors
  • Reserves themselves can either be gold or denominated in a specific currency, such as the dollar or euro

In a sense, holding any asset as part of a nation’s monetary reserves is a vote of confidence in it (which is a big reason central banks own tons of gold bars).

Here’s the concern: according to International Monetary Fund (IMF) data, the U.S. dollar (USD) has been hobbling along at a 26-year low in terms of its share of global reserve currencies.

Wolf Richter explained the specifics: “The global share of US-dollar-denominated exchange reserves declined to 59.15% in the third quarter, from 59.23% in the second quarter.”

The world is losing faith in the dollar as a safe, stable store of value. Take a look at the history of the USD share of global reserve currencies since 1967 on the chart below.

Take special note of how high the share was in 1977 (85%) before inflation spiraled out of control. Then note how much of that share disappeared by 1991:

The trends are pretty clear! No one in the world wanted dollars when their buying power declined. Then they liked dollars again when the U.S. economy strengthened and stabilized.

The introduction of the euro was the first real challenge to the dollar as the world’s global reserve currency of choice. For the last seven years, though, central banks have held about 20% of their reserves in euros.

If we  consider the fact that the USD is already starting from a much lower share percentage in 2022, with inflation spiraling out of control again, you can see why central bankers might be eager to replace their dollar reserves.

And that’s a real concern. We’re not talking about the “prestige factor” of the dollar as global reserve currency. This issue is about so much more than that.

The dollar’s role as deficit-enabler

Wolf Richter eloquently highlighted the benefits we’ve enjoyed due to the dollar’s role as a global reserve currency:

The US dollar’s status as the dominant global reserve currency has enabled the huge twin-deficits that are displayed in all their glory by the US government’s ballooning public debt, now close to $30 trillion, and by Corporate America’s relentless offshoring of production leading to the monstrous and ever-growing US trade deficits.

You can also take a glance at the overwhelming amount of U.S. debt in the line graph below, and see how sharply it has risen since 2008:


So one question to ponder might be: Who wants to buy more U.S. debt?

Or possibly, How much longer will the rest of the world finance our government’s deficit spending?

The Federal Reserve has been buying up the lion’s share of U.S. IOUs since the beginning of the pandemic panic, $5.5 trillion (and counting). The Fed’s committed to ending that practice in March, though.

Remember, China and other countries do buy U.S. debt in the form of Treasury notes, bonds and bills. The current global tensions involving Russia, China, and Taiwan could change that cozy relationship quickly.

For example, China cut some of its U.S. debt holdings in November 2020. That single act alone dramatically increased the cost of U.S. COVID stimulus. Remember, Treasury bonds are sold at auction. Fewer buyers and less demand means rates go up.

China has enabled U.S. deficit spending so much, for so long, that the Brookings Institute cautions us if they stopped a “calamity could follow.”

Couldn’t the government just print more?

Excessive debt in your own currency can lead to disaster, as we’ve discussed before.

When bills come due, inflation goes up if the dollar isn’t at the center of the action. That wouldn’t be good at all, since inflation is already higher than it has been in 25 years at 6.8%.

And yes, the government could “just print more.” That’s what Argentina did. In fact, the Argentine government printed so much currency they actually had to hire printing presses in Brazil and Spain to help them flood the nation with fresh pesos.

The result? Hyperinflation so severe that grocery stores have to use chalkboards so they can mark up prices hourly.

And guess how many world central banks hold Argentine pesos as a reserve? Zero. Not even the central bank of Argentina itself.

Clearly, this isn’t a situation the U.S. government can print its way out of. And the “prestige” that comes with global reserve status isn’t the only thing at stake here.

In fact, it looks like central banks have been exchanging their dollars for something they think is better…

Central banks are swapping dollars for gold

Even while central banks have sold off their dollars, they’ve increased their holdings of physical gold.

Why? Because gold is and always has been an internationally-recognized and accepted store of value. Gold is fungible like other commodities, and much easier to transport and store than other valuable commodities. (Imagine how a central bank would manage a national reserve composed of crude oil, uranium and corn and you’ll see why they prefer gold.) Because of its intrinsic value, gold is a trustless currency. There’s no IOU or promise to pay later. You either have the gold or you don’t.

As we know, there’s a limited and tightly-controlled supply of gold available. No one can make more of it just because they want to. Gold is uninflatable, hacker-proof and best of all still works when the lights go out.

Prudent investors might want to follow the lead of world central banks. Note that they haven’t eliminated dollars from their reserves; they’ve simply diversified away from dollars and into gold. For an individual investor, that would mean diversifying a portion of savings out of dollar-denominated investments into physical gold and silver.

As the dollar’s share of global reserves dwindles, the dollar’s buying power also fades. Central banks are smart enough to make their moves now, while the dollar is still useful. They know that waiting too long could become incredibly costly.

Should you decide this is a smart move for you, sooner is better than later. Delaying increases the risk of permanently losing buying power, and the risk of getting even less for your dollars than you could today. The more individuals who follow the lead of central banks, the more expensive gold will get. Thus, it’s just common sense to make your decision right now.

2022, central banks, Featured, federal reserve, us debt, us dollar